Notes to Consolidated
Financial Statements

The components of Income Before Provision for Income
Taxes,
Discontinued Operations and Cumulative Effect of Accounting
Change are as follows:

(dollars in millions

)

Years Ended December 31,

2006

2005

2004

Domestic

$

6,682

$

7,496

$

6,186

Foreign

1,472

952

1,791

$

8,154

$

8,448

$

7,977

The components of the provision for income taxes
from continuing
operations are as follows:

(dollars in millions

)

Years Ended December 31,

2006

2005

2004

Current

Federal

$

2,364

$

2,772

$

(162

)

Foreign

141

81

249

State and local

420

661

271

2,925

3,514

358

Deferred

Federal

(9

)

(844

)

1,580

Foreign

(45

)

(55

)

53

State and local

(190

)

(187

)

95

(244

)

(1,086

)

1,728

Investment tax credits

(7

)

(7

)

(8

)

Total income tax expense

$

2,674

$

2,421

$

2,078

The following table shows the principal reasons for
the difference
between the effective income tax rate and the statutory
federal
income tax rate:

(dollars in millions

)

Years December 31,

2006

2005

2004

Statutory federal income tax rate

35.0

%

35.0

%

35.0

%

State and local income tax,

net of federal tax benefits

1.8

%

3.6

%

3.0

%

Tax benefits from investment losses

(.9

)

(4.5

)

(3.7

)

Equity in earnings from unconsolidated businesses

(3.8

)

(3.5

)

(8.0

)

Other, net

.7

(1.9

)

(.2

)

Effective income tax rate

32.8

%

28.7

%

26.1

%

The favorable impact on our 2006 effective income
tax rate was primarily
driven by earnings from our unconsolidated businesses
and tax
benefits from valuation allowance reversals. These
favorable impacts
to the 2006 effective tax rate were partially offset
by the unfavorable
impact of tax reserve adjustments which is included
in the Other, net
line above. During 2006, we recorded a tax benefit
of $80 million in
connection with capital gains and prior year investment
losses.

During 2005, we recorded a tax benefit of $336 million
in connection
with capital gains and prior year investment losses.
As a result
of the capital gain realized in 2005 in connection
with the sale of our
Hawaii businesses, we recorded a tax benefit of $242
million related
to prior year investment losses. Also during 2005,
we recorded a
net tax provision of $206 million related to the repatriation
of foreign
earnings under the provisions of the American Jobs
Creation Act of
2004, which provides for a favorable federal income
tax rate in connection
with the repatriation of foreign earnings, provided
the
criteria described in the law is met. Two of our foreign
investments
repatriated earnings resulting in income taxes of
$332 million, partially
offset by a tax benefit of $126 million.

Deferred taxes arise because of differences in the
book and tax
bases of certain assets and liabilities. Significant
components of
deferred tax liabilities (assets) are shown in the
following table:

(dollars in millions

)

At December 31,

2006

2005

Employee benefits

$

(7,788

)

$

(1,778

)

Loss on investments

(124

)

(369

)

Former MCI tax loss carry forwards

(2,026

)

–

Uncollectible accounts receivable

(455

)

(375

)

(10,393

)

(2,522

)

Valuation allowance

2,600

815

Deferred tax assets

(7,793

)

(1,707

)

Former MCI intercompany accounts receivable basis difference

2,003

–

Depreciation

7,617

9,676

Leasing activity

2,638

3,001

Wireless joint venture including wireless licenses

12,177

3,001

Other – net

782

(370

)

Deferred tax liabilities

25,217

24,093

Net deferred tax liability

$

17,424

$

22,386

Net long-term deferred tax liabilities

$

16,270

$

22,831

Plus net current deferred tax liabilities

Net long-term deferred tax liabilities

1,154

–

Less net current deferred tax assets

(in Prepaid expenses and other)

–

445

Net deferred tax liability

$

17,424

$

22,386

At December 31, 2006, employee benefits deferred
tax assets
include $5,174 million as a result of the adoption
of SFAS No. 158
(see Note 15).

At December 31, 2006, undistributed earnings of our
foreign subsidiaries
amounted to approximately $3 billion. Deferred income
taxes are not provided on these earnings as it is
intended that the earnings are indefinitely invested
outside of the U.S. It is not practical
to estimate the amount of taxes that might be payable
upon
the remittance of such earnings.

The valuation allowance primarily represents the tax
benefits of certain
foreign and state net operating loss carry forwards,
capital loss
carry forwards and other deferred tax assets which
may expire
without being utilized. During 2006, the valuation
allowance
increased $1,785 million. This increase was primarily
due to the
addition of former MCI valuation allowances. This
increase was
offset by valuation allowance reversals relating to
utilizing prior year
investment losses to offset the capital gains realized
on the sale of
various businesses including Verizon Dominicana.

Former MCI tax loss carry forwards include federal,
state and foreign
net operating loss tax carry forwards as well as capital
loss tax
carry forwards. As a result of the MCI Bankruptcy
and the application
of the related tax attribute reduction rules, MCI
reduced the tax
basis in intercompany accounts receivables. This reduction
in tax
basis results in a deferred tax liability as reflected
above.

* This is an interactive electronic version of Verizon’s 2006
Annual Report to Shareholders, and it is intended to be complete and
accurate. The contents of this version are qualified in their entirety
by reference to the printed version. A reproduction of the printed version
is available in PDF format on this website.